Is the selloff for real?

Anthony Mirhaydari is a columnist and blogger for MSN Money who writes on stocks and the economy. He is also the founder and publisher of
the Edge, an investment advisory newsletter. Previously, Mr. Mirhaydari was a senior research analyst with Markman Capital Insight, an advisory and money management firm, and a business consulting analyst with Moss Adams, focusing on the financial-services industry. He studied finance at the University of Washington's Foster School of Business, graduating magna cum laude.

The market continues to do its best impersonation of a wild, untamed beast bucking from side to side.

There were more whipsaws and volatility on Thursday as stocks suffered their worst losses in six weeks on currency carry-trade weakness and more poor data out of China. Overnight futures trading suggests Friday will see a continuation of the weakness.

Like you, all of these swings are making me nauseous. Just look at the chart of the Japanese carry-trade proxy, the ProShares UltraShort Yen
YCS, +1.03%
YCS, as it dips and weaves like an All-Pro running back shredding a defensive line.

Things looked like they were about to sour in mid-February heading into an apparent breakdown on March 3. But then came the Putin bounce and an apparent upside breakout on March 6 and March 7. But it's been all downhill since then, culminating in Thursday's retest of the March 3 lows.

Are we going to see another reversal here, as a high-strung market doped up on cheap-money stimulus, late-stage bull-market excesses, including extended sentiment and record margin debt, stretched valuations, and a surge of money-losing IPOs on a scale not seen since the dot-com blowup resists the inevitable fall from grace?

Or is the selloff for real?

Given the fundamentals forces driving this move, and the fact the yen-carry trade was so crowded headed into this month, downside extension and the establishment of some directionality is the most likely path forward from here.

Thursday's action was enough to fully reverse the "Putin is backing down" rally following the Russian president's press conference last week in which he denied his intention to annex Crimea from the Ukraine. Anyone with a basic understanding of the gamesmanship of the former KGB man knew the market's reaction was garbage at the time. Yet, many felt obligated to play along given the market's demonstrated ability throughout 2013 to disconnect from reality for extended periods.

Only now are folks awakening to the fact that Putin was blowing smoke. And now, angrily, I'm recommending clients add back our original defensive positioning that we were carrying at the end of February.

Could we see additional whipsaws? It's always a possibility.

But the Dow Jones Industrial Average's drop through its 50-day moving average is significant in that all four of the last downside excursions below this level were extended, multi-week affairs. And it's worth remembering that the Dow hasn't had a significant drop below its 200-day moving average since late 2012.

The Nasdaq Composite, for its part, hasn't even touched its 200-day MA since late 2012.

So the market has bounced around over the last couple of months in a series of fakeout after fakeout, it looks like a modicum of directionality is about to return.

Why?

For one, the West has been raising the stakes in the fight over the future of Crimea this weekend, pledging to ignore the looming popular referendum on independence. Russia, for its part, is amassing troops and material on the Ukrainian border and is showing no signs of backing down as it conducts live fire drills.

There could soon be fireworks, of the lethal variety, over Eastern Europe.

Also, poor economic data out of China has dampened spirits. Industrial production grew less than expected. Fixed-asset investment was weak. Retail sales expanded at the slowest pace since 2004.

Economists at Societe Generale wrote, in a note to clients, that the data came in "vastly below our below-consensus forecasts, confirming the fast deterioration of China's economic growth entering 2014." Factoring in the already weak export data, and the simmering trouble in China's financial system, and things aren't looking so great for policymakers in Beijing.

Especially as they try to balance the needs of short-term growth against the need to rein in a dangerous debt bubble and the desire for long-term structural reforms of their credit markets.

Another point of pressure are the currency markets. Stocks and other risky assets had benefitted throughout 2013's record-setting performance from the consistent weakness of currencies like the U.S. dollar and the Japanese yen against the euro. Pair trades known as "carry trades" became popular as hedge funds would sell the weak currency short against the euro, using the proceeds to buy stocks.

The weakness in the yen carry — caused, confusingly, by strength in the yen — was helped by a dramatic intraday drop in the euro Thursday on comments from European Central Bank officials that new, extraordinary cheap-money stimulus measures could be forthcoming as a strong euro has damaged Europe's economy by trimming exports and pushed the inflation rate uncomfortably low.

In the context of a lack of hints of any new stimulus measures out of the Bank of Japan earlier this week — which disappointed a market expecting something in the wake of weak Japan GDP numbers over the weekend and the looming sales tax hike scheduled for April — carry traders were sent scurrying as the euro dropped hard against a strengthening yen. Stocks were sold to close yen-short/euro-long positions.

The main beneficiaries from all the chaos were safe-haven assets like gold, silver, precious-metals mining stocks, and U.S. Treasury bonds. All are areas I've been recommending for months amid growing concern over that state of the global economy. Examples include the Market Vectors Junior Gold Miners
GDXJ, -2.43%
Peruvian mining outfit Compania de Minas Buenacentura
BVN, -1.50%
and BanroBAA, +2.73%
I've added all three to my Edge Letter Sample Portfolio.

Disclosure: Anthony has recommended GDXJ, BVN, and BAA to his clients.

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